Confirmed: Central Banks Now Buying Stocks

As of April 22, 67% of the companies in the key stock indices that reported their corporate earnings were able to beat earnings estimates, but only 44% of them were able to exceed the revenue expectations of Wall Street analysts. (Source: Reuters Alpha Now, April 22, 2013.)

Looking at all this, you have to ask: why are the key stock indices rising when the underlying reasons for their rise (corporate earnings and growth) are diminishing?

The key stock indices aren’t climbing because of fundamental reasons. The harsh reality is that the yields from other investments are too low, so investors are forced to take higher risks to earn a decent rate of return. Just look at the yields on bonds of stronger governments around the world—most are barely beating inflation.

Even the most conservative investors, central banks, are rushing toward the stock market. According to a survey done by Central Banking Publication and Royal Bank of Scotland Group PLC of 60 central banks, 23% of them said they either own equities or plan to purchase them in the future. (Source:Bloomberg Businessweek, April 25, 2013.)

The central bank of Israel bought stocks for the first time last year. Similarly, the central bank of Switzerland and the Czech National bank have increased their stock holdings to at least 10% of their reserves.

The Japanese central bank has done the same. The Bank of Japan, the central bank with the second most reserves, expects to boost its holdings of equity exchange-traded funds (ETFs) to 3.5 trillion yen (about US$35.2 billion) by 2014.

Dear reader, central banks around the world usually hold safer asset classes in their reserves, such as gold, and government bonds, which they can sell in order to intervene in any major currency move (or to implement their monetary policy).

But since investment yields have collapsed in the global economy, central banks’ reserves are in danger. Some central banks have actually seen the value of their reserves decline! For example, the central banks of Taiwan and Singapore saw a collective decline of US$1.0 billion in their assets in 2012.

Looking ahead, this is troublesome for the key stock indices. The reason: as the most conservative investors, central banks, move toward the stock market, even just a little downward movement in equity prices will cause losses in their reserves.

The fourth-biggest hub in the eurozone, Spain, is facing a severe economic slowdown. According to Spain’s National Statistics Institute in Madrid, the unemployment rate in the country has surpassed the 27% mark, with more than six million people jobless—the highest number since 1976. (Source:Bloomberg Businessweek, April 25, 2013.)

Furthermore, the Bank of Spain reported that the Spanish economy contracted 0.5% in the first quarter of this year after witnessing a decline of 0.8% in the last quarter of 2012. The International Monetary Fund (IMF) expects this eurozone nation to contract 1.6% this year.

While Spain seems to be at the forefront of headlines about the eurozone, other nations like Portugal are witnessing a severe economic slowdown as well. The country has been experiencing a recession for three years, with its unemployment rate at a record high of 17%. (Source: Wall Street Journal, April 23, 2013.)

The situation in the eurozone is very critical; but if you look at the key stock indices, they do not portray this.

Even though Ford Motor Company (NYSE/F) was able to earn a profit in North America in the first quarter of 2013, its losses in Europe are piling up. The company posted a loss of $462 million in the first quarter in Europe, an increase of more than 210% compared to the same quarter of last year. (Source: Wright, R., “Ford reveals deeper European losses,” Financial Times, April 24, 2013.)

Ford is just one example of how U.S.-based multinational companies can face severe losses in the eurozone as the economic slowdown continues to take its toll on Europe. Even with all the austerity measures and bailouts by the European Central Bank, the eurozone is deteriorating further.

More troublesome is the fact that strong eurozone nations are starting to show weaknesses. Take a look at the two biggest economies in the region: France and Germany. Their growth is anemic at best, and the economic slowdown in those countries seems to be strengthening.

As I have been harping on about in these pages over the past few months, the eurozone’s economic slowdown is far from over, and I expect it to continue for a long, long time. Eventually, just like Ford, U.S.-based companies, especially the 40% of them listed on the S&P 500 that have sales in the eurozone, will see their losses mount—and stock prices reflect as much.

What He Said:

“What group of stocks are next to fall in light of the softening U.S. housing market? The stocks of companies that sell retail products to the American consumer, I believe, are next on the hit list. Many retail stocks are already reporting soft sales. In my opinion, they haven’t seen anything yet in respect to weaker sales.” Michael Lombardi in Profit Confidential, August 30, 2006. According to the Dow Jones Retail Index, retail stocks fell 42% from the fall of 2006 through March 2009.